Foundations of Finance, 7e (Keown/Martin/Petty)
Chapter 2 The Financial Markets and Interest Rates
2.1 Learning Objective 1
1) Common stock is considered a short-term security because it has no maturity date and a long-
term security is one with a maturity date of more than one year.
2) Saving surplus units include individuals and governments, but not corporations.
3) Individuals, corporations, and governments can be either savings deficit units or savings
surplus units.
4) A corporation needing cash sells securities to investors in the secondary market.
5) Part of the U.S. Government’s huge deficit is financed by foreign countries, such as China,
which is a savings surplus unit.
6) Venture capitalists typically provide funds to high-risk start up companies but take no active
role in their management.
7) Seasoned secondary offerings occur in the secondary market.
8) Capital markets are all the financial institutions that help a business raise long-term capital.
9) Transactions in the futures markets involve current payments for goods which will be
delivered at some future agreed upon date.
10) Organized stock exchanges provide the benefits of a continuous market, fair security pricing,
and helping businesses raise new capital.
11) On the basis of number of shares traded, more stocks are traded over the counter than on
organized exchanges.
12) Stocks listed on the New York Stock Exchange must be traded exclusively on the NYSE in
order to maintain the high standards set by the exchange.
13) One advantage of being listed on the NYSE is that all trades are made in an auction setting
with face-to-face trading between individuals on the floor of the stock exchange.
14) One advantage of organized stock exchanges is increased stock price volatility resulting from
the efficient exchange of pricing information.
15) Three ways that savings can be transferred through the financial markets to those in need of
funds include direct transfers, indirect transfers using the investment banker, and indirect
transfers using the financial intermediary.
16) Flotation costs are typically greater in the secondary market than in the primary market.
17) Each purchase occurring in the secondary markets increases the total stock of financial assets
that exist in the economy.
18) The money market includes transactions in short-term financial instruments.
19) Over-the-counter markets include all security markets, with the exception of organized
exchanges.
20) For a firm to have its securities listed on an exchange, it must meet certain requirements.
These usually include measures of profitability, size, market value, and public ownership.
21) The vast majority of corporate bond business takes place over the counter.
22) Financial markets exist in order to allocate savings in the economy to the demanders of those
savings.
23) A seasoned equity offering is the sale of additional shares by a company whose shares are
already publicly traded.
24) Primary market transactions cannot be undertaken in over the counter markets.
25) Financial intermediaries issue their own indirect securities and use the proceeds to purchase
the direct securities of other economic units.
26) Cash markets are often referred to as spot markets.
27) Which of the following statements is an example of a futures market transaction?
A) An investor purchases 100 shares of IBM hoping to sell it in two years for a profit
B) A company purchases an option to buy 1000 barrels of oil anytime between now and the end
of the year.
C) A company agrees to purchase 1000 barrels of oil for delivery in six months at a price of $70
per barrel.
D) An executive has a portion of his current year salary deferred until he retires.
28) General Electric (GE) has been a public company for many years with its common stock
traded on the New York Stock Exchange. If GE decides to sell 500,000 shares of new common
stock, the transaction will be describe as
A) an initial public offering.
B) a secondary market transaction because GE common stock has been trading for years.
C) a seasoned equity offering because GE has sold common stock before.
D) a money market transaction because GE raises new money to fund its business.
29) Money market instruments include:
A) common stock.
B) preferred stock.
C) T-bonds.
D) T-bills.
30) ExxonMobil generates about $50 billion in cash annually from its operations and invests
about half of that on new exploration. Therefore, ExxonMobil is an example of a(n):
A) savings surplus unit.
B) savings deficit unit.
C) investment banker.
D) financial intermediary.
31) Three ways that savings can be transferred through the financial markets include all of the
following except:
A) direct transfer of funds.
B) indirect transfer using the investment banker.
C) indirect transfer using the venture capital firm.
D) indirect transfer using the financial intermediary.
32) A wealthy private investor providing a direct transfer of funds is called
A) a venture capitalist.
B) an investment banker.
C) a financial intermediary.
D) an angel investor.
33) Common examples of financial intermediaries include all of the following except:
A) Venture Capital Firms.
B) Life Insurance Companies.
C) Pension Funds.
D) Mutual Funds.
34) John calls his stockbroker and instructs him to purchase 100 shares of Microsoft Corporation
common stock. This transaction occurs in the
A) secondary market.
B) primary market.
C) credit market.
D) futures market.
35) A life insurance company purchases $1 billion of corporate bonds from premiums collected
on its life insurance policies. Therefore,
A) the corporate bonds are indirect securities and the life insurance policies are direct securities.
B) the corporate bonds are indirect securities and the life insurance policies are indirect
securities.
C) the corporate bonds are direct securities and the life insurance policies are indirect securities.
D) the corporate bonds are direct securities and the life insurance policies are direct securities.
36) General Motors raises money by selling a new issue of common stock. This transaction
occurs in
A) the secondary market.
B) the capital market.
C) the money market.
D) the futures market.
37) Which of the following is an example of both a capital market and a primary market
transaction?
A) The U.S. Government sells 3-month Treasury Bills.
B) Microsoft common stock owned by an individual investor is sold to another investor.
C) Ford Motor Company sells a new issue of common stock to raise funds through a public
offering.
D) No transactions occur in both primary and capital markets at the same time.
38) All of the following securities are sold in money markets except:
A) common stock.
B) commercial paper.
C) 3-month U.S. Treasury Bills.
D) 6-month certificates of deposit.
39) Which of the following is an advantage of organized stock exchanges?
A) increased stock price volatility
B) screening companies to ensure only low risk stocks are sold
C) providing a continuous market
D) only profitable companies may issue new securities on an organized exchange
40) All of the following are benefits of organized stock exchanges except:
A) increased stock price volatility.
B) continuous markets.
C) fair security prices.
D) easier access to new capital for business expansion.
41) The stock market with the most stringent listing requirements is the
A) New York Stock Exchange (NYSE).
B) NASDAQ Stock Market.
C) American Stock Exchange (AMEX).
D) All organized exchanges have the same listing requirements in order to make trading fair for
all investors.
42) Bill is a public accountant auditing Expo Corporation. Based on information in Expo’s
confidential records, Bill recommends the purchase of Expo stock to his brother.
A) Bill is involved in insider trading prohibited by the SEC.
B) BIll’s brother has no direct connection to Expo Corporation and therefore his purchase of the
stock is not prohibited by insider trading laws.
C) Bill is not an insider because he is not an officer or employee of Expo Corporation
D) If Bill told a non-relative who purchases Expo stock, no insider trading laws would be
violated.
43) Capital market instruments include
A) negotiable certificates of deposit.
B) corporate equities.
C) commercial paper.
D) Treasury bills.
44) An example of a primary market transaction is
A) a new issue of common stock by AT&T.
B) a sale of some outstanding common stock of AT&T by an investor.
C) AT&T repurchasing its own stock from a stockholder.
D) all of the above
45) An example of a primary market transaction involving a money market security is
A) a new issue of a security with a very short maturity.
B) a new issue of a security with a very long maturity.
C) the transfer of a previously-issued security with a very short maturity.
D) the transfer of a previously-issued security with a very long maturity.
46) An example of a secondary market transaction involving a capital market security is
A) a new issue of a security with a very short maturity.
B) a new issue of a security with a very long maturity.
C) the transfer of a previously-issued security with a very short maturity.
D) the transfer of a previously-issued security with a very long maturity.
47) Financial intermediaries
A) offer indirect securities.
B) include the national and regional stock exchange.
C) usually are underwriting syndicates.
D) constitute the various secondary markets.
48) The telecommunications system that provides a national information linkup among brokers
and dealers operating in the over-the-counter market is called
A) NCIS.
B) NSQA.
C) NASDAQ.
D) NASQ.
49) Which of the following statements is false?
A) Brokers purchase securities for their own account.
B) Most corporate bond trading takes place over the counter.
C) Broker-dealers stand ready to buy and sell specific securities at selected prices.
D) none of the above
50) Insurance companies invest in the “long-end” of the securities market by purchasing
securities with longer maturities. In which of the following instruments would an insurance
company be least likely to invest most of its assets?
A) corporate stocks
B) corporate bonds
C) mortgages
D) commercial paper
51) Which of the following refers to all institutions and procedures that provide for transactions
in short-term debt instruments generally issued by borrowers with very high credit ratings?
A) capital market
B) commercial banks
C) money market
D) stock market
52) Which of the following is not a benefit provided by the existence of organized security
exchanges?
A) providing a continuous market
B) establishing and publicizing fair security prices
C) helping businesses raise new capital
D) standardization of all debt agreements
53) In August 2004, Google first sold its common stock to the public at $85 per share and raised
$1.76 billion. This is an examples of
A) a primary market transaction.
B) a secondary market transaction.
C) a venture capital firm transaction.
D) a money market transaction.
54) Money market transactions include which of the following?
A) any security that is paid for with cash
B) 30-year U.S. Treasury bonds
C) all securities paid for with the proceeds of a money market account
D) securities that have a maturity of less than one year
55) Capital market transactions include which of the following?
A) any security that is purchased from a brokerage firm that is well capitalized
B) common stock of a public corporation
C) all securities that are purchased in the open market
D) U.S. Treasury bills
56) Prices of securities that are traded on the organized exchanges are determined by
A) a “bid” and “ask” negotiation process amongst brokers who hold these securities in their own
account.
B) the Securities Exchange Commission.
C) a continuous auction process reflecting the sentiments of buyers and sellers.
D) the sellers of the securities.
57) Prices of securities that are traded in the Over-the-Counter Markets are determined by
A) the Federal Trade Commission.
B) a continuous modified auction process.
C) the buyers of these securities.
D) a “bid” and “ask” negotiation process of broker-dealers of these securities.
58) The Securities and Exchange Commission (SEC)
A) regulates only initial public offerings, or IPOs.
B) regulates only primary market transactions to ensure investors are provided with adequate and
accurate information on new securities.
C) regulates both primary and secondary markets.
D) regulates initial public offerings, but not seasoned equity offerings, in the primary market.
59) The New York Stock Exchange (NYSE) is
A) an automated electronic trading platform.
B) an auction market with face-to-face trading on the floor of the stock exchange in addition to
automated, electronic trading.
C) a hybrid market, allowing for face-to-face trading on the floor of the stock exchange in
addition to automated, electronic trading.
D) primarily a futures market.
2.2 Learning Objective 2
1) The difference between the price the corporation gets and the public offering price is called
the broker-dealer spread.
2) The need for extensive regulation of investment banking firms is limited due to the highly
competitive nature of that industry.
3) The investment banker performs three basic functions: (1) underwriting, (2) distributing, and
(3) advising.
4) The negotiated purchase is the most prevalent method of securities distribution in the private
sector.
5) When the corporation sells securities directly to the investment public without involving an
investment banker, it is called a privileged subscription.
6) An investment banker assumes underwriting risk in both negotiated purchases and privileged
subscriptions with standby agreements.
7) Investment banking firms are prohibited from selling securities due to conflicts of interest.
8) Transactions in common stock occur in the money market, due to the large amount of money
involved in such transactions.
9) The syndicate can be thought of as a wholesaler of securities and the dealer organization as a
retailer of securities.
10) A group of investment bankers organized to distribute large securities issues is known as a
syndicate.
11) It is common practice among the largest corporations to sell their securities directly to
investors.
12) The investment banker prefers to avoid a negotiated purchase because it tends to be the least
profitable arrangement for the investment banker.
13) The competitive bid purchase is largely confined to railroad, public utility, and municipal
bond issues.
14) The bid price is the price that a dealer will pay for a security; the asked price is the price at
which she will sell a security.
15) Because they occur in private, stricter regulations are placed on the private placement of
securities.
16) The investment banking business is dominated by a few very large, stand-alone investment
banking firms.
17) When a company repurchases its own common stock, it is likely that
A) the stock price will increase because the company views the stock as undervalued.
B) the stock price will decrease because the company is creating artificial demand for its stock.
C) the stock price will remain the same as this is simply an internal transaction.
D) the board of directors will be fired for incompetence.
18) Investment firms, such as Goldman Sachs, assist the transfer of capital by
A) facilitating indirect transfers from savers (investing public) to borrowers (corporations
needing capital).
B) selling indirect securities to savers and using the funds to buy common stock for corporations
needing funds.
C) selling direct securities.
D) selling common stock for corporate clients in the secondary market.
19) A corporation sells securities to an investment banking firm on January 1st. The next day an
international oil crisis causes stock prices to drop dramatically. The corporation is immune from
the drop in price of its stock due to which function of the investment banking firm?
A) hedging
B) distributing
C) reinsurance
D) underwriting
20) If a corporation wants a guarantee that all of its shares of stock will be sold, it should use
which of the following distribution methods?
A) competitive bid purchase
B) privileged subscription with no standby agreement
C) commission or best-efforts contract
D) direct sale
21) Reynolds, Inc. needs to raise $5 million by selling common stock. Reynolds sells 1 million
shares of stock at $5 each to Goldman Sachs, who then is responsible for selling the shares to
investors. This is an example of a
A) privileged subscription.
B) standby agreement.
C) negotiated purchase.
D) commission or best-efforts agreement.
22) Spandra Electronics wants to raise money by selling stock. After talking to several
investment banking firms, Spandra decides to hire Goldman Sachs to sell 5 million shares of its
common stock. Goldman sells 4.5 million shares and returns the rest to Spandra. This is an
example of
A) a privileged subscription with a standby agreement.
B) a commission or best-efforts agreement.
C) a privileged subscription with a standby agreement.
D) a competitive bid purchase.
23) Activities of the investment banker include
A) assuming the risk of selling a security issue.
B) selling new securities to the ultimate investors.
C) providing advice to firms issuing securities.
D) all of the above
24) The investment banker does not underwrite the securities to be issued in which of the
following?
A) initial public offering
B) primary market transaction
C) firm commitment
D) best efforts
25) Which of the following relationships is true regarding the costs of issuing the following
securities?
A) common stock > bonds > preferred stock
B) preferred stock > common stock > bonds
C) bonds > common stock > preferred stock
D) common stock > preferred stock > bonds
26) Which of the following statements about investment banking in the United States is most
correct?
A) Investing banking is dominated by a few, very large, stand-alone investment banking firms,
such as Bear Stearns.
B) The investment banking industry is dominated by large banks that are also investment
bankers.
C) The top five banks involved in investment banking account for less than 25% of the industry’s
total market share.
D) The investment banking industry became more competitive following the financial crisis in
2007 and 2008.